Magazine

Dashed Digital Dreams

July 14, 2002

When pressed a few weeks ago about what his company had done to marry entertainment with Internet and wireless technologies, Vivendi Universal (V) CEO Jean-Marie Messier insisted that the so-called digital convergence had arrived. His proof? For an extra $2.50 a month, Vivendi cellular customers in France can select snippets from songs by such Universal Music Group artists as Eminem or Sheryl Crow for their cell-phone ring tones.

That's it? A decade after Hollywood moguls and Silicon Valley propeller-heads alike began predicting the imminent arrival of a phenomenon they jokingly called Siliwood, there is precious little to show for it--at Vivendi or anywhere else. The half-dozen media companies that made the most serious forays into uncharted e-territories have since pulled back, including Walt Disney (DIS), AOL Time Warner (AOL), and Bertelsmann. In Messier's case, the attraction had some mighty serious consequences. On July 1, the company's board forced him to resign, largely due to his own missteps and scant results from his digital-convergence strategy

For a while, many media execs dreamed that by snatching up Web startups, Net and wireless-distribution systems, and cable-TV companies, they could create a new world. It was to be a utopia in which every kind of media--from movies to games to music--could be delivered to anyone, anytime, and anywhere via every imaginable gizmo and gadget.

Best of all, this "content" would be interactive: Consumers of digital fare would be able to choose one of several movie endings or shop until they dropped at a virtual mall. All of it was going to be paid for by advertising or micropayments attached practically invisibly to each activity, like buying a meal one bite at a time. It was to be the next bonanza--topping TV and the personal computer.

Messier's fall raises new questions about when, and even if, the convergence will pay off. Some companies will bail out completely. Vivendi is expected to consider spinning off its U.S. movie, TV, and music operations. Others--especially AOL Time Warner--are under intense pressure to prove that convergence can still work. Only the persistent and well-capitalized will be able to wait out the storm and emerge as powerful players when, perhaps years from now, the dreams of convergence may come to fruition. "What we've seen here is a false dawn," says media consultant Peter Kreisky. "Convergence is really, really hard work."

Its prospects have never looked so dim. Combining media businesses with Internet distribution and cable-TV systems was the rationale for one pricey acquisition after another at the height of the Net boom. It was why Vivendi shelled out $34 billion for Seagram and its Universal movie and music businesses and why Time Warner sold itself to America Online in a $81 billion all-stock deal.

But now these companies are being punished mercilessly by investors who don't like the loads of debt piling up and don't want to finance the additional $26 billion it will cost to finish providing broadband Internet service to every cable home--on top of $60 billion spent already. They're growing weary of reading the tea leaves of earnings before interest, taxes, depreciation, and amortization (EBITDA), a measure used by media companies that hides the impact of their debt.

Watch for a reversal of the hype-and-buy trend. Fee-hungry investment bankers who put these hybrid media companies together will begin to break them apart. "For years, Wall Street rewarded companies doing the most deals at the quickest pace with the best stock values," says Arthur Gruen, president of media consultant Wilkofsky Gruen & Associates. "Now, investors are looking more closely at the quality of profits. That could mean we see another cycle, like in the 1980s, of deconsolidation."

Given the ubiquity of the Net and growing access to high-speed cable connections, there's still a chance that many of the digital dreams of media companies will come true. The big question remains when. For years, the revolution was supposed to be just around the corner. Even now, many in the industry remain convinced that convergence will soon blossom. Tech market researcher Jupiter Media Metrix Inc. predicts the number of U.S. households with high-speed Net access will rise to 20.6 million in 2003, from 5.2 million in 2000. That, true believers maintain, should translate into huge growth of online revenues.

Maybe. But the days of convergence hype are clearly history. Nobody bought into that hoo-ha more wholeheartedly than AOL Time Warner, and no company has fallen as hard. Its stock, now trading at just $12 a share, has lost more than $100 billion in market value since the merger closed in January, 2001. Newly elevated CEO Richard D. Parsons pledges that he hasn't given up the vision that spawned the merger--and he has no plans to sell or spin off AOL. For now, though, the AOL unit execs are focusing on incremental changes, trying to boost ad revenues and buffing the flagship service with more search functions and easier broadband access.

What Parsons and other media moguls do next will determine which companies could eventually emerge as winners in the digital world. When it comes to producing compelling content for broadband services, AOL should have left others in the dust. But so far the company isn't exploiting its natural advantages. While it's featuring such things as online movie trailers and exclusive premieres of songs from Britney Spears, it hasn't tapped the treasure trove of Time Warner content. AOL won't launch a music-subscription service until late summer because its December trial version was a flop.

There's a risk to media companies in not being aggressive enough. While AOL plods along, for instance, nimbler rivals are dashing ahead. Of AOL's 26 million U.S. subscribers, only about 1% get a bundled broadband-access package through AOL, estimates Jupiter Media Metrix. AOL Chief Operating Officer Robert W. Pittman points out that more than 3 million AOL subscribers have lined up broadband connections on their own with other service providers. But meanwhile, cable operator Cox Communications Inc. (COX) is coming on strong. At the end of the first quarter, Cox had more than 1 million high-speed Net-access subscribers, or 16% of its 6.3 million users.

Others, badly burned by earlier aggressive moves, are taking a go-slow approach. In 1999, Walt Disney Co. invested $400 million to buy Starwave and Infoseek to create its Go Network portal. But amid disappointing results, Disney shut down the operation just two years later. It still plans to distribute its movies and TV shows on the Net and through wireless devices, but the grand strategy is kaput. "Some people tried to build their business models on aggressive projections. Those of us who had more modest expectations are feeling a little more comfortable right now," says Peter E. Murphy, executive vice-president of strategic planning at Disney.

One lesson from the boom-and-bust is that media companies may not have to own Net outlets to make the most of their opportunities on the digital frontier. Instead, owners of content can bargain with independent distributors to carry their music, movies, and other media. Viacom Inc., for instance, decided not to get into the distribution business. "We figured if we offered the best `oh, wow' programming out there, advertisers would pay up," says Richard Bressler, Viacom's chief financial officer.

If the ultimate benefits of owning both content and distribution are still a long way from being realized, the near-term penalty has clearly arrived. Media executives who bought into the convergence craze are now paying a steep price for their fascination. And none more than Jean-Marie Messier. By Tom Lowry in New York, with Ronald Grover in Los Angeles and Catherine Yang in Washington, D.C.